S&P, Volatility, and Copper Prices

Are copper prices signalling a top in the S&P?

The past five to six weeks have seen equity prices move considerably higher amid growing concerns regarding the European debt crisis, the instability of the Middle East, and ultimately the potential for a major economic slowdown in the United States.

US equity indexes have continued to climb the proverbial "Wall of Worry" since the first week of June and have put on an incredible run. This past Friday saw the S&P 500 Index (SPX) post the highest weekly close of 2012. The perma-bears have been calling for a top and continue to run scared as light volume and volatility have given the bulls an edge during August.

The next key overhead resistance level for the S&P 500 Index to hurdle is the 1,440 resistance zone. I try to refrain from calling tops or bottoms as I feel it's a fool's game that ultimately humbles most market prognosticators. If calling tops and bottoms were easy, investors and traders alike would be able to produce monster gains all the time with uncanny precision.

Instead of trying to predict where the S&P 500 Index will find resistance or create an intermediate to longer-term top, I will simply posit some technical and macro economic data which indicates that we are likely closing in on a major top.

As stated above, the recent rally we have seen has taken place on relatively light volume and plunging volatility as measured by the Volatility Index (VIX).

Volatility Index (VIX) Weekly Chart

As can be seen above, Friday's weekly close for the VIX was the lowest in 2012 and ultimately one of the lowest closing price levels in several years. While the VIX is trading at a major intermediate low, there remains a lower support level going back to late 2006 and the early part of 2007 around the 10 price level.

The perma-bulls would argue that we could see those 2006 – 2007 lows tested, but based on September monthly VIX options the option market seemingly is arguing that we are approaching an intermediate low in the Volatility Index. The chart below illustrates the September VIX option chain based on Friday's closing prices.

Volatility Index (VIX) September Monthly Option Chain

Price action is never wrong, but many times a great deal of information can be acquired by simply reviewing option prices. As can be seen above, the VIX closed on Friday at 13.45, a new 2012 low. However, when we consider the prices in the VIX September option chain shown above I would point out that the VIX September 13 puts are 0 bid.

What this essentially means is that the VIX options market is saying that the Volatility Index is unlikely to move below 13 in September. For readers unfamiliar with options, selling a naked put or using a put credit spread are two trading structures that are bullish regarding the underlying asset, which in this case is the VIX.

The VIX September 13 puts are offered at 0.05 on the ask, but are at 0 on the bid. This means that the VIX market makers are not expecting to see the VIX move below 13. Clearly this is not a guarantee as there is never a sure thing in financial markets. However, this pricing situation for the September 13 VIX Puts is favorable for the equity bears in September.

Another key element that veteran option traders understand is that going into a quarterly expiration, volatility typically recedes considerably. In light of that knowledge, experienced option traders would assume that the S&P 500 Volatility Index would have to rise in the intermediate term in order to allow for this volatility contraction synonymous with quarterly expiration.

In layman's terms, the VIX needs to move higher in the next three weeks based on the fact that the September VIX 13 puts are 0 bid. This is one of several clues that we could be nearing a major top in the S&P 500 Index in the very near future.

When we look at a weekly chart of the SPX, it is obvious that we have a major longer term breakout which occurred this past week. However, there remains additional resistance overhead in the 1,440 – 1,450 price range.

S&P 500 Index (SPX) Weekly Chart

While 1,440 might be a major area where a significant top could form, a rally above this level cannot be ruled out entirely. However, the chart above gives traders and investors a context for where possible tops could form.

A reversal could play out almost immediately at the current levels or we could move considerably higher before finding major resistance that holds. For now, we do not have enough evidence based on the S&P 500 Index price chart to proclaim that a top has formed or will form in the near future.

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